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Forecasting

Operations Management. For Competitive Advantage. Forecasting. Chapter 11 Forecasting. Demand Management Qualitative Forecasting Methods Simple & Weighted Moving Average Forecasts Exponential Smoothing Simple Linear Regression. Independent Demand: Finished Goods. Dependent Demand:

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Forecasting

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  1. Operations Management For Competitive Advantage Forecasting

  2. Chapter 11Forecasting • Demand Management • Qualitative Forecasting Methods • Simple & Weighted Moving Average Forecasts • Exponential Smoothing • Simple Linear Regression

  3. Independent Demand: Finished Goods Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc. A C(2) B(4) D(2) E(1) D(3) F(2) Demand Management

  4. Independent Demand: What a firm can do to manage it. • Can take an active role to influence demand. • Can take a passive role and simply respond to demand.

  5. Types of Forecasts • Qualitative (Judgmental) • Quantitative • Time Series Analysis • Causal Relationships • Simulation

  6. Components of Demand • Average demand for a period of time • Trend • Seasonal element • Cyclical elements • Random variation • Autocorrelation

  7. Seasonal variation x Linear Trend x x x x x x x x x x x Sales x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x 1 2 3 4 Year Finding Components of Demand

  8. Qualitative Methods Executive Judgment Grass Roots Qualitative Methods Market Research Historical analogy Delphi Method Panel Consensus

  9. Delphi Method l. Choose the experts to participate. There should be a variety of knowledgeable people in different areas. 2. Through a questionnaire (or E-mail), obtain forecasts (and any premises or qualifications for the forecasts) from all participants. 3. Summarize the results and redistribute them to the participants along with appropriate new questions. 4. Summarize again, refining forecasts and conditions, and again develop new questions. 5. Repeat Step 4 if necessary. Distribute the final results to all participants.

  10. Time Series Analysis • Time series forecasting models try to predict the future based on past data. • You can pick models based on: 1. Time horizon to forecast 2. Data availability 3. Accuracy required 4. Size of forecasting budget 5. Availability of qualified personnel

  11. Simple Moving Average Formula • The simple moving average model assumes an average is a good estimator of future behavior. • The formula for the simple moving average is: Ft = Forecast for the coming period N = Number of periods to be averaged A t-1 = Actual occurrence in the past period for up to “n” periods

  12. Simple Moving Average Problem (1) • Question: What are the 3-week and 6-week moving average forecasts for demand? • Assume you only have 3 weeks and 6 weeks of actual demand data for the respective forecasts

  13. 13 Calculating the moving averages gives us: F4=(650+678+720)/3 =682.67 F7=(650+678+720 +785+859+920)/6 =768.67 • The McGraw-Hill Companies, Inc., 2001

  14. Plotting the moving averages and comparing them shows how the lines smooth out to reveal the overall upward trend in this example.

  15. Simple Moving Average Problem (2) Data • Question: What is the 3 week moving average forecast for this data? • Assume you only have 3 weeks and 5 weeks of actual demand data for the respective forecasts

  16. Simple Moving Average Problem (2) Solution

  17. Weighted Moving Average Formula While the moving average formula implies an equal weight being placed on each value that is being averaged, the weighted moving average permits an unequal weighting on prior time periods. The formula for the moving average is: wt = weight given to time period “t” occurrence. (Weights must add to one.)

  18. Weighted Moving Average Problem (1) Data Question: Given the weekly demand and weights, what is the forecast for the 4th period or Week 4? Weights: t-1 .5 t-2 .3 t-3 .2 Note that the weights place more emphasis on the most recent data, that is time period “t-1”.

  19. Weighted Moving Average Problem (1) Solution F4 = 0.5(720)+0.3(678)+0.2(650)=693.4

  20. Weighted Moving Average Problem (2) Data Question: Given the weekly demand information and weights, what is the weighted moving average forecast of the 5th period or week? Weights: t-1 .7 t-2 .2 t-3 .1

  21. Weighted Moving Average Problem (2) Solution F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

  22. Exponential Smoothing Model • Premise: The most recent observations might have the highest predictive value. • Therefore, we should give more weight to the more recent time periods when forecasting. Ft = Ft-1 + a(At-1 - Ft-1) a = smoothing constant

  23. Exponential Smoothing Problem (1) Data • Question: Given the weekly demand data, what are the exponential smoothing forecasts for periods 2-10 using a=0.10 and a=0.60? • Assume F1=D1

  24. Answer: The respective alphas columns denote the forecast values. Note that you can only forecast one time period into the future.

  25. Exponential Smoothing Problem (1) Plotting Note how that the smaller alpha the smoother the line in this example.

  26. Exponential Smoothing Problem (2) Data Question: What are the exponential smoothing forecasts for periods 2-5 using a =0.5? Assume F1=D1

  27. Exponential Smoothing Problem (2) Solution F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

  28. The MAD Statistic to Determine Forecasting Error • The ideal MAD is zero. That would mean there is no forecasting error. • The larger the MAD, the less the desirable the resulting model.

  29. MAD Problem Data Question: What is the MAD value given the forecast values in the table below? Month Sales Forecast 1 220 n/a 2 250 255 3 210 205 4 300 320 5 325 315

  30. Month Sales Forecast Abs Error 1 220 n/a 2 250 255 5 3 210 205 5 4 300 320 20 5 325 315 10 40 MAD Problem Solution Note that by itself, the MAD only lets us know the mean error in a set of forecasts.

  31. Tracking Signal Formula • The TS is a measure that indicates whether the forecast average is keeping pace with any genuine upward or downward changes in demand. • Depending on the number of MAD’s selected, the TS can be used like a quality control chart indicating when the model is generating too much error in its forecasts. • The TS formula is:

  32. Simple Linear Regression Model Y The simple linear regression model seeks to fit a line through various data over time. a 0 1 2 3 4 5 x (Time) Yt = a + bx Is the linear regression model. Yt is the regressed forecast value or dependent variable in the model, a is the intercept value of the the regression line, and b is similar to the slope of the regression line. However, since it is calculated with the variability of the data in mind, its formulation is not as straight forward as our usual notion of slope.

  33. Simple Linear Regression Formulas for Calculating “a” and “b”

  34. Simple Linear Regression Problem Data Question: Given the data below, what is the simple linear regression model that can be used to predict sales?

  35. Answer: First, using the linear regression formulas, we can compute “a” and “b”. 35 • The McGraw-Hill Companies, Inc., 2001

  36. The resulting regression model is: Yt = 143.5 + 6.3x 36 Now if we plot the regression generated forecasts against the actual sales we obtain the following chart: 180 175 170 165 Sales 160 155 Forecast Sales 150 145 140 135 1 2 3 4 5 Period • The McGraw-Hill Companies, Inc., 2001

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